Who Makes Markets? Liquidity Providers Versus Algorithmic Traders

We investigate the roles of liquidity providers ( LP s) and algorithmic traders ( AT s) using a complete derivative warrant trading record of all investors in K orea. The main empirical findings indicate that LP s, the sole traders responsible for making market, do not trade primarily for liquidity provision. Instead, AT s provide liquidity. We further study the profitability of LP s and AT s and decompose their profits into information, market making, and mixed components. The results provide strong evidence that LP s earn profits using information about the future prospects of derivative warrants. AT s, however, are much better at sustaining profits by providing liquidity. Surprisingly, our evidence shows that though LP s earn positive total profits, AT s generally incur losses by trading. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 33:397‐420, 2013